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Can Congress Save the PBGC? Implications of a Delphi Corp. Distress Termination of Pension and Benefits Plans in Bankruptcy

The negotiation efforts of Delphi Corp.'s union employees took on
new urgency on March 31 as Delphi filed a motion with the U.S.
Bankruptcy Court seeking to reject its collective bargaining agreements
and modify its retiree benefits plans under sections 1113 and 1114 of
the Bankruptcy Code. [1] If Delphi's pension and benefits obligations
are ultimately rejected and then terminated, it will have a profound
effect on the Pension Benefit Guaranty Corp., the federal agency that
insures pension obligations. Already operating at a deficit, PBGC can
ill-afford to take on any of Delphi's estimated $10.7 billion in
under-funded liability for hourly employees' retirement benefits. [2]
In response to the recent distress terminations of pension plans in the
steel and airline industries, Congress has introduced several measure
to bolster the PBGC. As a consequence, Chapter 11 debtors may find it
more difficult to avoid pension liability as part of a reorganization
plan.

Termination of Delphi's Executory Contracts Under the Bankruptcy Code

The Bankruptcy Code allows a trustee or debtor-in-possession to
reject executory contracts subject to the court's approval. [3] The
Code provides parallel provisions for granting rejection of collective
bargaining agreements (including employee benefit and pension plans)
under section 1113(c) and modification of retiree benefits (including
health care and life insurance) under section 1114(g) insofar as the
rejection or modification is necessary to permit the reorganization of
the debtor. [4] In addition to meeting a heightened "balancing of the
equities" standard for court approval, the trustee or
debtor-in-possession is required to negotiate in good faith its
termination or modification proposal with the authorized
representatives of its employees towards the goal of reaching "mutually
satisfactory modifications" to the proposal. [5]

Delphi reported to the court that "[w]ithout modifications to its
labor agreements or to its retirement obligations… Delphi would
suffer operating losses ranging from approximately $6.1 billion to $8.1
billion, and net losses ranging from approximately $11 billion to $13
billion, over the next five years." [6] Those projections to not begin
to cover the long term under-funding of its retiree health, life, and
pension benefit obligations. While Delphi plans to freeze and retain
its defined benefit contribution plan, it acknowledges that "it will
also be necessary to obtain relief from the [PBGC], Internal Revenue
Service, Department of Labor and potential congressional action in
order to amortize funding contributions over a longer period in its
transformation plan than may have previously occurred." [7] Further,
Delphi reserved the right in its Motion to later terminate the plans if
necessary. [8]

The unions representing Delphi's workers, led by the UAW, complain
that this filing will stall the already bitter negotiations and may
lead to strike action. UAW President Ron Gettelfinger issued the
following statement to that effect:

Delphi's
misuse of the bankruptcy procedure to circumvent the collective
bargaining process and slash jobs and wages and drastically reduce
health care, retirement, and other hard-won benefits or reduce them
altogether is a travesty and a concern for every American. … In the
event the court rejects the UAW-Delphi contract and Delphi imposes the
terms of its last proposal, it appears that it will be impossible to
avoid a long strike. [9]

As a show of good
faith, Delphi requested in its Section 1113 and 1114 Motion that the
court extend the 14-day limit for scheduling a hearing as prescribed in
section 1113(d)(1) and instead hold the hearing on May 9th and May 10th
to allow the parties time to continue negotiations. [10] Delphi CEO
Steve Miller explained that:

Our
fiduciary duty as the management team and the Board of Directors at
Delphi is to protect the value of the estate. We need to take the steps
necessary to halt losses that continue to occur at an unsustainable
rate and transform our business. Although today's court filings are
necessary to protect our business, we have not left the negotiating
table. We have made considerable progress in recent weeks, and we
intend to stay at it until we are finished. [11]

Little Recourse Available to Delphi Employees in the Event of Rejection and Termination

As indicated in the statement by Ron Gettelfinger above,
the unions object to the motion on the grounds that Delphi has failed
to negotiate in good faith or provide the most complete and reliable
information available as required by section 1113(b) and 1114 (f). At
the hearings, the UAW must show instead that Delphi's proposals failed
to fulfill the statutory requirements, and that the UAW therefore
refused to accept the proposals for good cause. [12] Based upon the
length of the negotiations and the financial burden the agreements pose
to Delphi's restructuring plan, it is likely that the UAW's objection
will fail and the motion will be granted.

If the pensions provided for in the collective bargaining
agreement are ultimately rejected under section 1113, and liability for
health care and life insurance benefits for retired employees is
eliminated under section 1114, Delphi's employees have three avenues
from which to seek some relief: Delphi's bankruptcy estate, General
Motors, and the Pension Benefit Guaranty Corp. As the following
sections will show, none of these options will ensure full payment of
accrued and future benefits to Delphi employees.

1. The Effects of Rejection of Executory Contracts Under the Bankruptcy Code

Rejection of an executory contract is generally treated as
an anticipatory repudiation by section 365(g) [13] and gives rise to a
general unsecured claim under section 502(g)(1) of the Code. [14] This
is likewise the case for retiree benefits plans that are reduced or
eliminated under section 1114's modification provisions. The employee
benefit plans under section 1113, by contrast, are afforded priority
unsecured statute for those benefits arising within 180 days of the
bankruptcy petition up to a statutory limit. [15] Claims for lost
employee benefits beyond that limit and all retiree claims are
relegated to general unsecured status, which means that the employees
may only recover a pro rata share with the other general unsecured
creditors of Delphi's bankruptcy estate. If Delphi has insufficient
assets once the secured and priority unsecured claims are paid, then
the employees will receive nothing from the estate. Furthermore, since
all such claims will receive final discharge in the bankruptcy
proceeding, there is no future recourse against Delphi when it emerges
from Chapter 11.

2. The GM Benefit Guarantee and the Section 1114(g) Modification

At the time of its 1999 spin-off from General Motors,
Delphi assumed liability for the GM-UAW collective bargaining contracts
of its workers. GM in turn guaranteed retiree medical and life
insurance benefits for hourly employees in the even Delphi declared
bankruptcy. Under section 1114(g), Delphi seeks to eliminate its
obligations entirely as to employee-beneficiaries of the GM Benefit
Guarantee agreement, which could cost GM as much as $12 billion. [16]
For all other employees, Delphi would substitute a defined-contribution
benefits plan. [17] Given GM's current financial trouble and the high
number of employees not covered by the GM Benefit Guarantee, this is
unlikely to be a satisfactory solution. Furthermore, since the PBGC
only covers pension benefits, not health and welfare benefits, Delphi
employees and retirees are looking at substantial losses if the motion
is granted.

PBGC was created in conjunction with the Employment
Retirement Income Security Act of 1974 (ERISA). [18] It is financed by
premiums paid into PBGC by providers of defined benefit contribution
plans, termination penalties paid by former providers, the assets of
plans that it administers, and investment income. If a plan provider
proves to the bankruptcy court or PBGC that its pension and benefit
plan is under-funded and that the company cannot remain in business
unless the plan is terminated, then PBGC will grant an application for
"distress termination." [19] The PBGC steps in as trustee of the plan
and pays beneficiaries according to annual tables created under ERISA.

In a stunning reversal, recent distress terminations in
the steel and airline industries have taken PBGC from a $9.7 billion
surplus at the end of 2000 to its current $23.3 billion deficit. [20]
United Airlines alone burdened the PBGC with an addition $6.6 billion
in un-funded liabilities. [21] The Congressional Budget Office
estimates that PBGC's deficit could balloon up to $141.9 billion over
the next twenty years. [22]

Recent Congressional Responses to PBGC Deficits Brought on by Distress Terminations of Pension and Benefits Plans in Bankruptcy

Currently, the PBGC derives no funding whatsoever from
taxpayers, and the 109th Congress introduced a series of measures aimed
at keeping it that way. Pending bills include the Pension Protection
Act, [23] the Pension Security and Transparency Act, [24] the Pension
Fairness and Full Disclosure Act, [25] the Stop Terminating Our
Pensions Act, [26] and the Bankruptcy Fairness Act. [27]

Substantial changes affecting the funding of PBGC are
found in the Deficit Reduction Act of 2005, a budget reconciliation
bill signed into law on February 8, 2006. This Act increases
single-employer plan providers' annual premium of $19 per worker to
$30, the first premium increase since 1991. [28] The premium rate
increase would thereafter be indexed to inflation. The Act also imposes
a termination premium payment of $1,250 per plan beneficiary (as of the
date of termination) to be paid by single-employer plan providers each
year for three years. For distress terminations by Chapter 11 debtors,
this penalty becomes effective upon discharge or dismissal of the case.
[29] The termination penalty provision will sunset after five years;
however, given the extent of PBGC's deficit, the severity of pension
under-funding, and the low rates of return on its investments, it is
likely that this penalty will continue to be enforced indefinitely.

Incidentally, BAPCPA, the 2005 amendments to the
Bankruptcy Code, did little to change the availability of rejecting or
modifying pension and benefits obligations in Chapter 11. [30] However,
Delphi's decision to file in advance of the October 17, 2005 effective
date of BAPCPA has given it an unexpected windfall: the termination
penalty provisions in the Deficit Reduction Act do not apply to those
Chapter 11 cases filed before October 18, 2005. [31]

"Lemon Socialism" and the Future of Distress Terminations in Bankruptcy

Professor Chason illustrates in a recent article how the
PBGC may actually encourage financially weak companies to engage in
risky practices such as borrowing from their pension and benefits plan
assets because of the PBGC guarantee, whereas financially strong
companies tend to fully fund their pensions. The PBGC guarantee is thus
a form of what professor Chason describes as "lemon socialism", the
subsidization of weaker firms at the expense of stronger firms. [32]
Adequately funding the PBGC to cover its existing and future
obligations, while generally discouraging its use, are significant
challenges for the future.

The Deficit Reduction Act's termination penalty provisions
will impose new onerous burdens on Chapter 11 estates seeking to reject
pension and employee benefits in the debtor's collective bargaining
agreements and shift coverage to the PBGC. This will make the plan
confirmation process more difficult and expensive. However, increasing
burdens on the estate will also increase the bargaining incentives
between the trustee/DIP and the employees' representatives to avoid
this cost. The unions' common complaint is that trustees/DIPs make a
mere showing of good faith intent to bargain, but nonetheless present
proposals demanding impossible concessions. When the unions refuse, the
trustee moves for rejection. This puts enormous power in the hands of
the trustee/DIP. The plan termination penalty may in fact create some
equalization, thereby increasing the chances of a successful
negotiation of an assumption proposal. However, these penalties and
premium increases only go so far. Unless Congress implements more
substantial measures to fund PBGC and discourage debtors from distress
terminations, taxpayers may be asked to open their checkbooks.

[30] Specifically, Congress added section 1114(l), which
operates to reinstate retiree benefits that were modified in the
180-day period before the bankruptcy petition was filed if the debtor
was insolvent at the time, unless the court finds that the balance of
the equities clearly favors such modification. 11 U.S.C. § 1114(l) (West, 2006).